A pragmatic approach to reform of banking governance and culture

Blogpost: Alexandra Zeitz, St. Antony’s College, University of Oxford

Speaker: John Mellor, University of Leicester

Chair: Adam Bennett, St. Antony’s College, University of Oxford

What does it take for a bank to be well governed? In Michaelmas term, PEFM hosted John Mellor of the University of Leicester for a seminar on reforming banking governance and culture. Mellor’s headline argument was that the quality of bank governance is directly shaped by a bank’s culture, which in turn is defined by the purpose or objective that the bank sets itself. He used case studies of three well-known banks, Nationwide, Rothschild, and Barclays, to illustrate the determinants of high and poor quality bank governance.

While it is oft discussed, Mellor suggested that bank governance is in fact poorly understood. He argued that analysis of bank governance must begin with the bank’s board of directors, since the directors hold ultimate responsibility for the bank’s conduct. Governance, from the bank’s board downward, is influenced by both internal and external factors. Internally, bank governance is shaped by the ownership of the bank, its business model and history, while important external circumstances are the competitive and political environment and the structure of regulation. 

Ethics and cultural assimilation in financial services

Ivaylo Iaydjiev (St Antony’s College, Oxford)

Speakers: Alan Morrison, Saïd Business School, and John Thanassoulis, Oxford-Man Institute, University of Oxford

Chair: Natalie Gold, King's College London

With a string of scandals in finance in the last few years, it is not rare to hear people lamenting the decline of ethical behavior in the industry, including the Archbishop of Canterbury and Pope Francis. In their new paper, Alan Morrison and John Thanassoulis want to go further and understand the causes behind the many failures.[1] Drawing on the use of contracts of finance and their role in incentivizing certain behavior and fostering a culture, they present an elaborate model of cultural assimilation in a professional services firm.

The starting point for their argument is the moral dilemma that bankers face in acting on behalf of their clients. In considering the trade-offs of actions that are simultaneously harmful to the client and profitable to the company, traders are likely to be affected by cultural standards and the tone from the top. The question then becomes how performance pay affects such decisions and why a principal might decide to create a less ethical culture. Their model includes two versions of the actors, one based on a utilitarian Benthamite conception that focuses on increasing the aggregate welfare surplus, and the other based on Kantian duty ethics that consider actions separately from their context. 

Managing Complexity—Economic Policy Cooperation After the Crisis

G. Russell Kincaid (St. Antony’s College, Oxford)

Speakers: Tamim Bayoumi, Deputy Director, International Monetary Fund (IMF); Fred Bergsten, Senior Fellow and Director Emeritus, Peterson Institute for International Economics; Heidi Crebo-Rediker, Senior Fellow, Council on Foreign Relations; and Vitor Gaspar, Director Fiscal Affairs Department, IMF

Moderator: Kemal Dervis, Vice President and Director, Global Economy and Development, The Brookings Institution

According to Mr. Bayoumi, this new book adopts a Cubist Approach to analyzing economic policy cooperation. Like the art school, the 12 chapters in Managing Complexity—authored by various academics and practitioners, including two current PEFM Associates—do not depict the subject from a single vantage point, but provides multitude perspectives to picture all the intricacies. This event, was held at the Brookings Institution in Washington DC on May 16, followed similar presentations earlier in 2016 at Chatham House and in Shenzhen, China at a conference on global financial governance. The book’s main thesis rebuffs the “benign neglect” approach to policy cooperation owing to new challenges posed by interlinked financial stability and the “new normal” economic environment.

Fred Bergsten endorsed strongly the message that the benefits from policy cooperation are far greater in tough times—a point made in the chapter by David Vines—seeing a need to ensure that cooperation frameworks are in place and ready to respond promptly—like fire fighters. He added that having more policy issues on the table helps by opening up more trade-offs and allowing more avenues to a successful conclusion. He stressed the importance of inclusiveness—having all the policy actors at the table, in particular emerging market economies such as China. 

Continuing the latter point, Ms. Crebo-Rediker emphasized the complex interactions from spillovers and spillbacks especially from capital flows, resulting from our ever more multi-polar global economy. In this connection, she recommended the four chapters on policy responses to the crisis. She highlighted the important cautionary lessons in the chapter on the euro-area responses, which was accurately subtitled “A Case of Too Little, Too Late” written by an insider, Fabrizio Saccomanni.

What they do with your money: Does the finance industry do its job well?

Ivaylo Iaydjiev (D.Phil. Candidate, St Antony’s College, Oxford)

Speaker: David Pitt-Watson, London Business School
Chair: David Vines, Balliol College, Oxford

What does the financial industry do with your money? That is the misleadingly simple question that motivates David Pitt-Watson’s new book (co-authored with Stephen Davis and Jon Lukomnik). Given the large amounts of fees we pay in transparent or often less so ways to financial professionals, this is a particularly pertinent question. More broadly, it invites us to step back from the complex and technical details that dominate everyday financial news and revisit how we think about the role of the financial system and its contribution to society. 

Mr. Pitt-Watson examines in his talk whether the financial industry does its job well, and his conclusions are not particularly optimistic. Intriguingly, he decides to tackle the question by first reconnecting financial activity with its initial purpose. As he aptly points out, there is a voluminous literature on what financial institutions exist, but it tends to proceed by assuming that the existence of such institutions must serve a purpose, and then deducing what that purpose might be. Instead, it is necessary to be clear on what the original purpose is and work out the institutions from there.

For Mr. Pitt-Watson finance serves four key purposes, largely in line with the academic literature. The first key function is the safekeeping of assets, especially money. In turn, this is central to the second function – transaction-processing, or reducing the costs of financial exchange. The third function is the sharing of risk through the provision of insurance, which however does not reduce the aggregate amount of risk. Finally, the financial system’s most important purpose is to intermediate funds from savings to investment. 

These four functions demonstrate that finance does indeed have a socially beneficial purpose. However, he is careful to point out that this purpose relies on technical knowledge as much as on trust in the institutions and financiers themselves. When knowledge and trust are combined with a sense of purpose, the results can be transformative. Therefore, finance is key to our economies, to opportunities for social mobility and development, and to addressing our current challenges.

Financial Reform in Turkey: Responses to Past and Current Crises

Alexandra Zeitz (St Antony’s College, University of Oxford)

Speaker: Gazi Ercel, Former Governor of the Central Bank of Turkey
Chair: Nicholas Morris, St. Antony’s College, University of Oxford

How to prevent cycles of financial crises in emerging market economies? What interventions and reforms can stabilize and strengthen these economies in the aftermath of a financial crisis? Drawing on his extensive experience in Turkey, Gazi Ercel, former Governor of the Central Bank of Turkey, shared his insights on financial crises and reform in a PEFM seminar in late April, stressing the importance of reducing political uncertainties and ensuring post-crisis reforms are carried through once economic conditions improve.

Examining the record of financial crises in Turkey in the last four decades, Ercel identified common causes. In almost all crises the country has faced in recent history, public sector deficits had expanded, which provoked investors to withdraw short-term capital and in turn plunged the economy into crisis. For instance, Ercel attributed the inflows of large volumes of short-term capital in the lead up to the 1978-1979 crisis to a positive World Bank report. When these investors abruptly and rapidly withdrew in light of worsening public sector imbalances, the country experienced its worst foreign exchange crisis in three decades.

Domestic political economy, especially the pressure for a rising public sector wage bill, is at the root of the persistent public deficits that prompt financial crises, argued Ercel. The instability of Turkish politics exacerbates this problem, disincentivizing fiscal discipline as governments seek to maintain their hold on power.

In addition to identifying these Turkish political dynamics, Ercel argued that the particular causes of financial crises in emerging economies are distinct from those in developed economies. While industrialized economies are more likely to experience crises in their capital markets, emerging economies are frequently hit by debt crises. Emerging markets are likely to have weak and unsophisticated banking sectors, which may cause fragility, while instability in developed economies stems from the complexity and lack of transparency in banking sectors.

A code of ethics for bankers – Challenges and opportunities

Alexandra Zeitz (St Antony’s College, Oxford)

Speaker: Robert Mass, Head of International Compliance, Goldman Sachs
Chair: David Vines, Balliol College, Oxford

The financial services sector continues to grapple with a string of headline-grabbing scandals. One interpretation of this has been that the industry suffers from a serious shortfall in ethical standards. Various solutions have been offered for the apparent “culture problem”. High profile commentators have argued, for instance, that managers should set a “tone from the top,” correcting for deficits in ethical standards by modelling conscientious behaviour towards clients, competitors and co-workers and expecting the same from those further down the ladder.

One popular response to the seeming problem of values has been to set out ethics codes that explicitly commit bankers to clear normative standards. Barclays, for instance, unveiled a code of conduct in 2013 as part of its efforts to address the cultural deficits that underlay the foreign exchange-fixing and personal protection insurance scandals. In 2015, the G20 released a set of Principle of Corporate Governance. What can such codes achieve, and what should they include?

In February, PEFM hosted Robert Mass, Head of International Compliance at Goldman Sachs, to discuss his proposals for a code of ethics for bankers. Mass’ engagement with codes of ethics was incredibly wide-ranging, spanning both the philosophical and pragmatic.

In order to be effective, says Mass, codes of ethics must be rooted in existing social practice, in the day-to-day lives and expectations of those they hope to influence. Drawing on moral philosophers including Hume and Smith, Mass argues that ethical standards cannot be given a priori; instead, cultural norms arise out of particular cultural milieus and conventions. The challenge of an ethics code is to set out the principles contained in existing practice, to codify them, in order to encourage socially appropriate behaviour.

The Eurozone crisis and South East Europe: Recovery or illusion?

Alexandra Zeitz (St Antony's College, Oxford)

Speakers: Adam Bennett, St. Antony’s College, Oxford; and Peter Sanfey, European Bank for Reconstruction and Development 

Chair: Jonathan Scheele, St. Antony’s College, Oxford

In late January, the PEFM seminar series was treated to a data-rich and fascinating account of the crisis experience of South East European states.  Adam Bennett of St. Antony’s College and Peter Sanfey of the European Bank for Reconstruction and Development (EBRD) presented the book they co-authored with Russell Kincaid, formerly of the IMF and the late Max Watson, also formerly of the IMF and founding director of PEFM.

Economic and Policy Foundations for Growth in South East Europe (Palgrave, 2015) reviews the experience of crisis in the ten South East European economies and argues for renewed commitment to reform to ensure sustained prosperity.

The South East European (SEE) states comprise Albania, Bulgaria, Romania and the seven successor states of former Yugoslavia. Bennett outlined three distinct phases of development in this region since the onset of “transition” in 1990. The first ten years he characterized as the “valley of tears”, as countries variously underwent the dismantlement of economic systems and then rebuilt them, or were ripped apart by conflict. The second phase comprised the boom years of the first part of this century through the onset of the global economic crisis at the end of 2008, when all countries managed to achieve remarkable (and too good to be true) growth rates—the “sunlit uplands” of peace and fruition of reform. The final phase, where SEE arguably remains today, was characterized as the “wilderness years” of post crisis recession followed by stagnation.

Though there were of course idiosyncrasies in their economic trajectories in the build up to the crisis and stagnation of 2009-2014, the trends across the region are instructive. On the basis of detailed country-level data, Bennett described the emergence of a massive savings gap in these economies during a boom period that stretched from 2000 to 2008.